Searching for Life on Hulu

Just over a year ago, Hulu sold out its advertising inventory. And while still a nascent offering, that was a notable achievement in a world of Internet startups largely focused on capturing users before dollars. Not that the site lacks for viewers: Hulu has grown at a clip not anticipated even by its own backers. In February, less than a year after launch, Hulu became the Internet’s second-most-popular video site, trailing only YouTube, according to Nielsen.

Hulu has taken the lead in forging a business model for legal long-form Internet video, a content area that didn’t even exist as recently as three years ago. Originally dismissed by critics, including some at YouTube parent Google who referred to it as “Clown Co.,” Hulu was derided as a flawed strategy, a digital outlet for old media that consumers had no interest in watching.

But advertisers viewed its potential differently, with 200 marketers signing up with Hulu in the past year. That said, in recent months, the amount of unsold inventory given over to public-service ads has been equally visible.

The answer as to why that’s been happening may lie in the amount of new supply that has come with the site’s jump in viewers, combined with the glut of broadcast inventory during this economic downturn. After Hulu debuted its “Alien” ad with Alec Baldwin on the Super Bowl, for example, the site saw a rise of more than 40 percent in streams.

“Hulu experienced a major surge after the Super Bowl, and I think they were trying to be somewhat conservative — it was hard for them to predict that increase to advertisers,” says James Kiernan, vp and group client director at Publicis Groupe’s MediaVest. “It would have been difficult for them to have sold advertisers prior to that increase.”

More fundamentally, Hulu is caught in between an Internet model and a broadcast model, one that media buyers have yet to fully understand or accept. Media agencies are still set up for scale buys; that’s how they make their money, and Hulu doesn’t fit well within that model. Additionally, video on the Internet is increasingly sold on the basis of audience and behavior, while traditional broadcast still uses content as a proxy for audience.

“What is troubling is that some of the inventory that’s been unsold has been in attractive programs with devoted audiences in the Internet zone and coveted demographics in 18-34,” says James McQuivey, an analyst with Forrester Research. “I think ad buyers don’t know where the Internet fits into their overall media buying yet. It’s part B of a two-part buying process, where they buy TV first. Now that the first part is rebounding, maybe the second part will also rebound, but there are still some fears that online video won’t pick up until the fall season.”

Now, with a new partner in Disney, Hulu offers more premium content than any of its Internet video competitors. In addition to original backers NBC Universal and Fox, Hulu works with 150 content providers, including all of the major TV production companies with the exception of CBS, which is aggressively developing TV.com.

Hulu’s traditional backers created the site as a hedge against the industry’s digital future-seeking to avoid the mistakes the music industry made in dealing with Napster-and as a way to control and monetize their content on the Web. But Hulu’s growth is said to have even surpassed their own expectations, and sources familiar with the site say that leaving a lot of inventory unsold at Hulu is a calculated measure so network CPMs don’t slip.

 
“The fact that Hulu has succeeded so quickly, particularly since the Super Bowl, has taken its partners by surprise,” says an industry source. “Partly, it’s a load issue, but it’s also about the fact that the more Hulu succeeds, the more its partners fail. [NBC Universal CEO] Jeff Zucker says he’s only getting 10 cents on the dollar as the business transitions from analog to digital. So, with the success of Hulu, you’re driving business away from an advertising model that works for the networks to one that does not. [Hulu’s partners are] not so focused on increasing ad dollars at Hulu as they are in protecting the mothership.  They’re still figuring digital out, and they need to find a way to increase those digital dimes to at least quarters or 50 cents. They’ll give up an additional $20-50 million in ad revenue rather than get the model wrong and cannibalize themselves.”
 
Even while in beta, Hulu attracted eight charter advertisers: The site took a known model — pairing high-quality video content with ads — and added some of the best characteristics of the Web. That’s a far cry from the other big growth area of the Web, social networking, which is trying to shoehorn advertising into communications-something that’s never worked well. But content-for-attention is a model that both advertisers and consumers understand and, mostly, accept.

YouTube maintains a commanding lead over Hulu in traffic and brand recognition. In April, YouTube had total streams of 5.5 billion, about even with March’s number, and 83.7 million unique visitors, according to Nielsen Online. Hulu had 373 million streams, an increase of 25 million over March, and 7.4 million unique visitors. (comScore counts Hulu’s uniques as higher.) But YouTube has been unable to convert that traffic into ad dollars from advertisers, who are wary of the amount of user-generated content on the site.

YouTube has scrambled to add premium content. Since November, it’s added TV episodes, movies and videos from CBS, ABC, MGM and Sony Pictures. (While it now has more than 500 movies, its offerings are still dwarfed by Hulu’s.) Even Google, which bought YouTube, then less than 2 years old, for nearly $1.7 billion in November 2006, has publicly admitted that its acquisition still isn’t generating “significant” revenue for the company. Google no longer breaks out YouTube’s financials, but in 2006, the last year it did so, the site posted a loss of $276 million.

“Up until this point, YouTube has not had a lot of inventory,” says Jon Gibs, vp of media analytics at Nielsen (the parent company of AdweekMedia). “It hasn’t been positioned as an ad-supported site. They haven’t had a consistent packaging of ad product or message in the marketplace to advertisers until this year. Obviously, advertisers have been concerned about the amount of user-generated content, but that’s been somewhat assuaged by YouTube’s move into premium content.”

Hulu has attracted blue-chip marketers like Nissan, Toyota, Intel, Procter & Gamble, General Motors, Cisco and Chanel. (Several advertisers contacted for this story either declined to comment or did not return calls.) As a private company, Hulu has been tight-lipped about its finances. Jean-Paul Colaco, Hulu’s svp of advertising, declines to discuss ad growth other than to say the site is ahead of its targets for both revenue — Hulu is known to be very strict in holding to rates — and ad impressions in both the first and second quarters. Analysts estimate it earned some $65 million in revenue last year, and other sources expect it will command 10 percent of the fledgling online video ad market this year-an industry that is expected to grow 45 percent to $850 million this year, according to eMarketer. But industry players say Hulu, like YouTube, is losing money, after sharing up to two-thirds of its revenue with its content partners, and paying for streaming and maintenance costs, estimated by one source to be $1 million a month and growing.

A Hulu rep would not say whether the site is profitable, but Colaco says: “Catching ad sales up to traffic takes time, particularly with the strong headwinds we’ve had. March was our highest month ever, so we’re extremely pleased with our growth in advertising, and we continue to focus to be the most effective online video site available.”

In his bid to sell marketers on premium online video, Colaco has one of the medium’s most attractive propositions in Hulu’s clean, easy-to-use interface and highly targeted ROI. Even with that advantage, Hulu’s experience over the past 14 months underscores the learning curve in the online premium video market, with challenges that range from high CPMs and marketers’ siloed media buying budgets to the lack of measurement tools to compare it with other broadcast media.

Colaco says monetization has been a priority since day one: Hulu’s digital video concept, created from the ground up, has been predicated equally on the needs of viewers, advertisers and content providers, to which Hulu does not pay license fees but shares revenue. Hulu sells just two minutes of ad time per half hour, to a single sponsor — about 75 percent less commercial time than a typical prime-time TV show. Viewers can often choose whether they want to see the ads upfront or interspersed throughout the video.

“We feel it’s extremely important to be very respectful of the balance between the advertising you watch and the content you consume,” says Colaco. “Folks have less patience watching video online. They also have less patience seeing the same ad over and over, so marketers should avoid repetition and use this as an opportunity to use a series of ads to tell a story and then get to the call to action at the end.”

Hulu asks users to register personal data like age, gender, location, education, household income, employment, marital status and whether they have children under 18. Though sharing that information is not required, Hulu said it has signed up “millions” of registered users. (The company will not be more specific than that.) In the past couple of months, Hulu, working with behavioral targeting company Audience Science, has launched additional initiatives like “retargeting,” which uses cookies to monitor a user’s browsing history. A consumer who visits P&G’s pg.com, for example, will see P&G advertising when they watch Hulu content. Hulu’s ad-selector option also allows viewers to choose the kind of ad they want to see: An automotive marketer might offer the choice between watching a spot for a sports car, a minivan or a sedan.

“It’s great for the user. They can control their ad experience,” says Colaco. “We learn a lot about the user, about their life stage and experiences and who we can target. Over time, we can create a profile for that person and get a whole set of interests for that user.”

Hulu says proprietary research from Nielsen IAG shows “unusually high brand recall and purchase intent.” Partly, that may be because users are more engaged when viewing video at the close distance of their laptops, generally speaking. With Hulu specifically, the site has a much less cluttered environment than the online video streams at broadcast network sites.

That comes at a cost: Hulu’s inventory carries a high CPM, thought to be anywhere from $25 to $40. (Colaco declines to confirm those industry estimates.)

Broadcast TV, with its larger audiences, commands about $30, depending on daypart. By some estimates, about $10 of Hulu’s CPM reflects bandwidth costs that are increasing along with Hulu’s growing popularity, as the site streams more and better-quality video. Even before the current economic slide, that pricing made some marketers reluctant to experiment with the site. Buyers say Hulu’s CPMs need to come down.

“There’s been a lot of action done at those prices, but there’s a feeling that the market hasn’t established itself yet, and some people are waiting to see if these prices are going to come down,” says Kristian Magel, evp and director of national broadcast at Interpublic’s Initiative. “The effectiveness on a per-impression basis is significant, but even when you factor that in, some advertisers don’t want to pay those CPMs for a TV spot.”

Jason Kilar, Hulu’s CEO, who spent nearly a decade at Amazon, was the architect of that site’s entry into the video and DVD business. His digital expertise gives Hulu a distinctive difference compared to other, more traditional broadcast video sites. If linear TV is about appointment-based programming, Hulu represents data-based programming. “Hulu is run by digital-only folks with a fabulous background in data management, data mining,” says Magel. “It’s more sophisticated in targeting measurement and gives consumers more choice. What Hulu does offer that’s unique is that it is building a database of digital users. They can behaviorally target, contextually target more so than other online video sites.”

Having said that, Magel adds that there are still obstacles that may put off advertisers: Some might not have the rights to use their TV spots in another medium, and they might not want the additional production required to create longer-form creative or repurpose existing spots for Hulu, whose viewership is dwarfed by other broadcast options. Advertisers might still be siloed when it comes to media budgets: One company might include online video as part of its digital budget, and those ad buyers see more effectiveness per dollar in other digital options. Another might regard online video as more brand and research driven, more like buying TV, and allocate a portion of TV spending for it.

Some media buyers also voice concern about knowing exactly what they’re paying for with Hulu, which primarily sells by program genre as opposed to specific network program.

“I like Hulu as a user experience; they do a great job. But from an advertiser perspective, I can’t tell who is viewing what program,” says Gibbs Haljun, managing director of media investment for North America at WPP’s Mediaedge:cia. “I can’t tell if the impressions are coming off Hawaii Five-O or 30 Rock. When I buy NBC, I ask for ‘x’ number of units, impressions in that show, or I say, ‘Stay away from Law & Order SUV because of content.’ Hulu can’t tell me how many impressions I’m getting against a particular show. They can’t tell me if what I’m buying is additive to my TV buy or duplication.”

Carrie Frolich, managing director of digital media at Mediaedge:cia, adds: “From a digital perspective, the amount of money invested is still driven by performance and efficiency, and Hulu’s CPMs are very, very premium to what we buy in the digital space.”

Some even wonder if Hulu should rethink its ad model. “If your ad-sales model is not based on a typical targeted CPM like normal TV, maybe that’s another reason to rethink it,” says MediaVest’s Kiernan. “Maybe it would be better to look at something like a cost-per-engagement model? On TV, everything is based on Nielsen demos. While Hulu has definitely rolled out sophisticated targeting, it’s not apples-to-apples — it doesn’t translate to the way buyers and sellers usually buy. On the other hand, for a digital buyer who has been buying online advertising for the past 10 years, it has become very sophisticated in targeting. While Hulu’s rollout has been targeted, it’s still not quite there yet.”

Like lots of new advertising vehicles, Hulu doesn’t fit neatly into a media planner’s spreadsheet. While a digital-media exec like Kiernan is looking for more specific audience targeting, a more traditional TV buyer wants GRPs to fit his broadcast criteria.

Another factor affecting the visibility of Hulu’s paid advertising is that the site syndicates its content. “A great amount of Hulu inventory doesn’t run on Hulu’s site. It runs on other sites,” notes Nielsen’s Gibs. “There’s a bit of social media going on with Hulu’s syndication of content. It used to be the consumer is king, then content was king. Now, with online video, distribution is king.”

That syndication is a key part of Hulu’s growth strategy. “Hulu wants to become a network,” says Shahid Khan, a senior partner at media firm IBB Consulting Group. “Hulu is a destination and wants to capture traffic on their site as well as others.”

Earlier this year, Hulu made a misstep that underscores the fragile ecosystem it inhabits alongside its broadcast partners, which are protecting their own business models. Hulu had allowed Boxee — a startup that offers free software that makes it easy for users to stream video through their TV screens or other large monitors — to access its content. Effectively, Hulu became a mini cable network-and a free competitor to the subscription cable and satellite operators that underwrite cable-network programming. In January, a feature on Boxee appeared in The New York Times, with a photograph showing Hulu’s logo on a TV monitor behind the service’s founder. Within weeks, Hulu was forced to withdraw from Boxee, angering many users.

At another point this year, Hulu found itself apologizing to viewers for the abrupt removal of past episodes of FX’s slacker show It’s Always Sunny in Philadelphia. The Fox-owned cable network pressed Hulu for the shift after becoming concerned that the show’s popularity on Hulu would undermine its ratings on cable and undercut DVD sales.

On Hulu’s blog, Kilar apologized about the Boxee issue and addressed the challenges of serving the site’s various constituents: “While we stubbornly believe in this brave new world of media convergence — bumps and all — we are also steadfast in our belief that the best way to achieve our ambitious, never-ending mission of making media easier for users is to work hand in hand with content owners. … For those Boxee users reading this post, we understand and appreciate that you’re likely to tell us that we’re nuts. Please know that we do share the same interests and won’t stop innovating in support of the bigger mission.”

In fact, Hulu may offer a glimpse of the new world that traditional broadcasters face. Almost two years ago, Omnicom media agency OMD entered into partnership with Hulu when it was still in beta and has continually renewed the association. Robert D’Asaro, OMD Digital’s U.S. director of strategic alliances, says the experience was as much about learning about the future of TV as making an impact for the agency’s marketers.

“There’s a belief that eventually there will not be that great a divide between what occurs in the digital space and the broadcast space,” D’Asaro says. “Look at broadcast efforts like Canoe or Google TV. They’re serving advertisers at a set-top-box level that is very similar to digital. Whether it’s five or 10 years from now, eventually that’s the way broadcast will be purchased. There will be a back-end ad server with demographics on a household level.”